News & analysis

USD

Calmer cross-asset conditions saw the dollar track marginally lower, with losses greatest against currencies that have borne the brunt of souring investor sentiment in recent weeks. In the G10, this saw the euro stage a recovery to climb back above 1.07, while previously dumped LatAm currencies came back into favour.  On the euro front, we doubt that the recent rally marks an inflection point and instead look for the currency pair to weaken back below 1.07 into the weekend as the French election draws closer. It is in emerging markets, specifically Latin America, which is of greater interest to us. A sense of political stability has led both BRL and MXN to retrace back below key psychological levels ahead of what will be a busy week in terms of data. In Mexico, unemployment data and Banxico’s latest decision are released on Thursday. While we expect Banxico to hold rates at 11%, the risk of a 25bps cut is elevated given slowing activity and Mexico’s high ex-ante interest rate. Meanwhile, the focus will remain firmly on the stand-off between the BCB and the government in Brazil this week, with tax revenue data released today ahead of inflation and government debt data tomorrow. No news has been good news for BRL in recent days, but a soft inflation print mixed with deteriorating fiscal balances could bring frictions back to the fore for investors, prompting BRL to take another leg lower.

In terms of the broad dollar, we expect it to play a support role in markets until Thursday night when the first presidential debate is scheduled on CNN. As we highlighted yesterday, the dollar’s reaction will likely be gauged by how hawkish each candidate sounds of China, trade protection as a whole, and their stance on fiscally supporting the economy. In addition, the perceived “winner” of the debate will also play a role in markets, especially as some markets are showing traders price in election risks earlier than usual in the cycle. Beyond the debate, Friday’s PCE report will be the main focus for markets. Whether it too shows the evaporation of core services inflation will be key, especially as hesitation remains when pricing the Fed’s easing cycle. Swaps currently assign a 70% chance of a rate cut in September and an 80% probability of a second cut in December, marginally underpricing our base case.

EUR

“Stop comparing us to Liz Truss” was the message from National Rally’s top finance official yesterday, as he tried to defuse the concerns sparked by incumbent Finance Minister Bruno Le Maire in the hours after Macron unexpectedly dissolved the National Assembly. Jean-Philippe Tanguy went on to reinforce National Rally’s commitment to cutting the sales tax on energy and fuel as its first policy at a cost of €7bn if elected, funded through cutting support for immigration policies, closing tax exemptions for some companies, and paring back France’s contributions to the EU. While this still poses a risk, Tanguy confirmed that any further measures will be subject to a review of the nation’s finances, in a tip of the hat to investors that suggests the party will respect the nation’s budget rules. This helped close peripheral bond spreads slightly, enabling EURUSD to climb back above the 1.07 handle as the single currency led gains against the dollar in the G10 on the day at 0.4%.

Despite yesterday’s price action, we are hesitant to join the bull camp for the euro at this moment in time. The commitments by National Rally to respect the public finances seem a pre-election ploy that may not be respected should they take office. Moreover, there is still a risk that the New Popular Front will outperform the polls this weekend, leaving them more likely to take office in a scenario that will cause greater market concerns given their more expansive fiscal stance. As such, we remain in the bear camp and expect EURUSD to close the week in the mid-to-low 1.06s.

GBP

Monday’s slide in the dollar saw GBPUSD drift 0.3% higher, even as the pound finished the day flat against the euro with little news out of the UK. In fact CBI order book and selling price data were the only releases of any note, and these showed both order and selling prices overshooting expectations in June. With this broadly consistent with other recent data points, traders were happy to overlook what is typically considered as a third tier data release. Instead, the focus remains on the general election campaign, despite a lack of market moving developments to date, a dynamic that should stay unchanged today given a blank data calendar.

CAD

While BoC Governor Macklem hit the airwaves to kick off the week, his comments on the Canadian labour market and inflation did little for the loonie, which traded broadly in line with other G10 currencies on Monday, rising 0.25% against the greenback. As such, today’s release of May’s CPI data will be the main event for CAD traders this week. We expect the data to confirm the overall disinflationary backdrop in Canada, which should support more bearish expectations for the BoC, though with another round of top-tier data set to be released ahead of the July 24th meeting, we doubt expectations of a cut will rise much from 60% currently. Markets project headline price growth of 0.3% MoM and 2.7% YoY in May, down from 0.5% and 2.7% in April respectively. Perhaps more importantly, core-median inflation is projected to stabilise at 2.6% YoY, while core-trim inflation should fall 0.1pp to 2.8%. This would be in line with our preview of today’s release, where we noted that core inflation pressures in Canada have dropped off a cliff since the start of the year, with prices growing at a monthly rate of just 0.136% over the past quarter, almost half the run rate a year ago. As we see it, an inline print today would be sufficient to reverse the rally in the loonie at the start of the week, though we also think a sharp break higher for USDCAD looks unlikely today. Granted, slower price growth momentum and a negative output gap suggest that risks for today’s print are skewed towards a negative surprise in the data. But, as mentioned, a further inflation report is due before the BoC next makes a rate decision on July 24th, alongside a GDP print later this week and a labour market report early next month. With this in mind, we think it is a high bar to radically shift market expectations for BoC easing in a substantially more dovish direction.

 

 

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